Economic and Stock Market Update (3rd Quarter 2018)
We value communication with our clients regarding their accounts and the atmosphere surrounding the markets in general. Each client receives a personalize letter each quarter updating them on the performance of their individual portfolios, the assets that they hold and where we think that the market is going.
This is a letter that we send to our clients every quarter. It will be individualized with their personal account performance.
Gross Investments News
Gross Investments is pleased to announce that Bret Hartman has passed Level III of the Chartered Financial Analyst (CFA) exam and is now an official charterholder. The CFA credential is a badge of distinction in the investment management profession. It represents a deep knowledge of all things investing, a commitment to ethics and a passion for always putting investors first. CFA charterholders work in the most prominent investment firms around the world. Earning the CFA credential required diligence, tenacity and a significant commitment of time and energy.
Economic and Stock Market Update
U.S. GDP was very strong for quarter two, growing at 4.2%. Our best-case scenario has U.S. GDP growing between 3-3.5% for 2019 as the consumer remains financially healthy and corporations continue gains from the tax cuts. However, fiscal deficits are running without a leash and we may pay a high price in the future. Strong short-term fundamentals consist of low unemployment (3.9%) and a recent uptick in wage growth and higher savings rates. These factors, along with a strong U.S. dollar, should result in the U.S. economy once again leading the global economy. Interest rates continue to rise and are now reaching a level where they will no longer stimulate growth. There has been some positive development in the trade wars (see below), but the looming threat of a full-on China/U.S. trade war will cause uncertainty in markets and will hit the bottom lines of major corporations.
New trade deals with Canada and Mexico (USMCA) are modest changes to NAFTA, but positive nonetheless. The South Korea trade deal is a win, but remember South Korea is a very small economy. Japan is coming to the trade table, and we view this as positive as well. Trade with the above countries is not similar to trade with China. First, much more is at stake with China in terms of our trade deficit and the impact on U.S. corporations. Lazard Asset Management came out with an analysis that stated that if tariffs are enforced and then retaliated against, S&P 500 companies will have up to a 10% hit to profits if costs aren’t passed onto consumers. The stock market would need to adjust for this.
Besides the unpredictable trade war with China, our next largest worry is an overheated economy. Consumer sentiment is at levels we haven’t seen since the dot com bubble, and tax cuts for consumers and corporations will need to push GDP past 3% growth to “pay for themselves.” Fiscal deficits could grow to $1 trillion next year, with debt totaling over $21 trillion. The CBO expects annual deficits to grow at 5% for the next ten years, meaning that nominal GDP will have to grow at that pace to keep up. That will be tough. In the great recession from 2008-2009 the U.S. was running a similar deficit, but for good reason–the economy needed to be stimulated. Fast forward to 2018 (10 years into the second longest bull run), and we are juicing the economy when growth already existed. The Federal Reserve will try to combat this by raising rates.
Equity Portfolio Update
Forward valuations have not changed since our last letter.
|Forward PE (Last QTR)||Forward PE|
U.S. valuations remain the same since our last letter. We believe markets would be fairly valued if we excluded the impact of potential tariffs on U.S. corporate profits. Valuations are not only rich in the tech sector, but also in mature, slower growing S&P 500 companies. We have a slightly overweight to technology as the margins and growth can justify some stocks PE levels (and other fundamentals). Our overweight to the MLP space remains as valuations remain attractive. We are expecting price appreciation to historical averages. While we wait for this appreciation, we will collect a high dividend. U.S. financials are held in the portfolio, but we do not own the major banks. For example, we own names such as Blackstone, KKR, Capital One and Virtu Financial. Our technology names consist of some chip makers that have been caught in the crosshairs of the China-U.S. trade spats. We believe these companies will lead the way in a world where the “Internet of Things” will be a part of everyday life. We have started to add names such as Facebook and Google as the stocks sold off on non-fundamental news. We also use Columbia Global Technology in many portfolios to add tech exposure.
International and EM equities trailed the U.S. stock market in quarter three. This was for good reason, as GDP came in below expectations and real political and economic risks have risen. Examples include tariffs, Chinese consumer debt, BREXIT concerns, Brazilian elections, Russian sanctions, Turkish currency problems and worsening problems in Italy. These events have occurred in the backdrop of what has been a global expansion. When the cycle ends, expect these problems and volatility to intensify. We hold a mix of value and growth managers who implement active strategies. Passive investing in EM and Int’l has not seen the success that U.S. passive investing has seen.
Bond Market Forecast and Update
The yield curve is relatively flat, but we do not expect an inversion until late 2019. We have been finding attractive rates across the yield curve, including up to 4% returns for 10-year bonds of high quality. The Fed raised rates to 2-2.25% in September and there is a chance of another rate hike in December. Expect at least two rate hikes in 2019.
Short-term high-quality taxables (2-3 years) are yielding roughly 3% vs. the 10-year Treasury rate of 3.2%. We are maintaining the ladder and buying some longer-term maturities. Currently the two-year treasury is 2.8%, the ten year is 3.2% and the 30 year is 3.4%.
Money market fund yields keep increasing as the Fed raises rates. Current yields on Vanguard Federal MMF are 1.95%, Vanguard Prime is 2.15% and Vanguard Tax Free is 1.45%. Depending on tax bracket, one of these funds should be an excellent vehicle to hold short-term cash.
This section is for the account performance for each client’s individual investments.
This section is for informing our clients of all the transactions that took place in their portfolios throughout the quarter. We regularly meet with our clients to stay current with their income, tax and financial situations.
Donald R. Gross, Jr., CFA
Bret Hartman, CFA